Everyone’s betting on a rate rise – but that might be a big mistake

The signals could not be clearer. The governor of the Bank of England, Mark Carney, has dropped some heavy hints that interest rates will see their first rise in seven years some time in the autumn.

Members of the Monetary Policy Committee, both past and present, have been lining up to tell us that rates will have to go up imminently.

Policymakers are able to say this because the economic climate is improving. Growth is decent. Unemployment is falling rapidly. House prices are booming. New jobs, and new businesses, are being created. The deficit is coming down. Business confidence is rising.

What’s more, the current low rates were meant to be ‘emergency’ rates, but there isn’t much sign of an emergency right now. So it seems only sensible to start pushing rates back to their normal levels – not least because it would be good to have some scope to cut them again the next time the economy turns down.

In response to all of this, City traders have been pushing the pound higher and lenders have been nudging up interest rates. It is about as close to a done deal as the City ever gets. The trouble is, a rate rise is not nearly as certain as everyone now assumes. There are at least four surprises that could derail it.

First is a geopolitical crisis. The uprising in Iraq has turned very nasty, and could easily turn into a regional war, sucking in Iran and Turkey, and in turn the US as well. It is only a few weeks since everyone was worrying about the conflict in Ukraine, and its border with Russia remains tense.

America is now reluctant to involve itself in conflicts and that’s one reason why the world is becoming a dangerous place again. If a serious war breaks out somewhere, commodities such as oil will soar in price, and trade will slump. And that rate rise will be swiftly forgotten about.

Second is falling prices. The eurozone is slipping into a deflationary spiral, with prices falling in many countries, and inflation close to zero across the region. There is no reason to think that we are immune from that just because we aren’t in the euro.

Hungary, for example, is already in outright deflation, and it’s not inside the single currency either. Since around 18% of our GDP isaccounted for by imports from Europe, there is no reason why our prices should not fall along with Europe’s.

Indeed, British inflation is already falling fast and the higher pound will reduce it even further. If inflation hits zero, or minus 0.2% by the autumn, is the Bank still going to raise rates?

Modern central banks regard deflation as the greatest of all evils. And of course, with prices falling, even a 0.5% interest rate will look quite high. If that happens, a rate rise is about as likely as Ed Balls admitting the economy is doing well again.

Third, the coalition could fall apart. The Liberal Democrats may well decide the only way to save any seats at the next election is to walk out of the government early and put themselves in opposition.

Either David Cameron would have to soldier on alone with a minority government for six months, or he would have to call an early election. Either way, the Bank would be reluctant to add to the instability with the first rate rise since the crash.

Finally, there could be a stock-market collapse. Are markets dangerously overstretched and heading for a big fall? Or is this just the start of another ten-year bull market, with the FTSE heading all the way up to 12,000, or even higher?

Just like everyone else, I don’t really have any idea. What is clear is that taken from the lows of 2009, this has already been an exceptionally long bull run by any historic standards, and a major crash should be about as surprising as rain interrupting play at some point during Wimbledon.

If that happens, the Monetary Policy Committee is going to file that plan for a rate rise in the small circular cabinet underneath the desk.

Any of these scenarios might happen, or none of them. Something else entirely unexpected might come along between now and the autumn to change the outlook for the world economy – the four possibilities outlined above are only the fairly obvious ones.

In reality, all Mark Carney and the rest of the Monetary Policy Committee are engaged in right now is a fresh version of the infamous ‘forward guidance’ with which Carney started his term as governor. And that didn’t survive for long either.

In fact, Carney has no more idea what the world will look like in October than the rest of us do. He might well be planning to put rates up then, if the world looks exactly the same as it does now. The chances of that are not very high, however.

The economy changes all the time – and eachtime it does so, the case for an adjustment in monetary policy will change with it.

Rates will rise one day, when all the arguments for putting them up look compelling, and when inflation shows signs of needing to be brought under control. Until the day a rise is
announced, however, it’s not a done deal – and if the City thinks it is, it’s making a mistake.


Claim 12 issues of MoneyWeek (plus much more) for just £12!

Let MoneyWeek show you how to profit, whatever the outcome of the upcoming general election.

Start your no-obligation trial today and get up to speed on:

  • The latest shifts in the economy…
  • The ongoing Brexit negotiations…
  • The new tax rules…
  • Trump’s protectionist policies…

Plus lots more.

We’ll show you what it all means for your money.

Plus, the moment you begin your trial, we’ll rush you over THREE free investment reports:

‘How to escape the most hated tax in Britain’: Inheritance tax hits many unsuspecting families. Our report tells how to pass on up to £2m of your money to your family without the taxman getting a look in.

‘How to profit from a Trump presidency’: The election of Donald Trump was a watershed moment for the US economy. This report details the sectors our analysts think will boom from Trump’s premiership, and gives specific investments you can buy to profit.

‘Best shares to watch in 2017’: Includes the transcript from our roundtable panel of investment professionals – and 12 tips they’re currently tipping. The report also analyses key assets, including property, oil and the countries whose stock markets currently offer the most value.